The concept here is simple: Take a well-liked company on Motley Fool CAPS and completely debunk the notion that it's worth buying. Does this mean after I put a company through the ringer that it's worth selling? Maybe, maybe not -- that's up to you to decide. The point of "Bash My Stock" is to expose the fact that there's another side to every trade, and this series will attempt to look at the bearish view of why a stock might not be such a great value. Today, I suggest we take a closer look at fast-food giant McDonald's (NYSE: MCD).
Don't let its four-star Motley Fool CAPS rating fool you because this stalwart is without question one of the most beloved companies, according to our community members. Of the 5,589 members who have weighed in on McDonald's, an overwhelming 95% of them believe that the company will outperform the S&P 500.
The optimists do have plenty of bullish signs they can point to as can be highlighted by the company's earnings report released on Friday. In that report, McDonald's reported a 14% jump in revenue and a 12% jump in its quarterly profit over the year-ago period, and raised its dividend by 15%. There is a reason so few companies are Dividend Aristocrats, and without question McDonald's -- with its 35th consecutive year of raising its dividend -- belongs on that prestigious list.
And yet, there are warning signs on the horizon signaling that things maybe not be as perfect as last week's results would indicate. McDonald's shareholders, it's time for me to bash your stock.
Too much Greece
No, I'm not talking about the amount of exercise you'll need to endure to burn off the calories gained from eating a Big Mac and large fries. Instead, I'm talking about the other Greece.
Before you optimists start waiving European same-store sales figures in front of me, let me begin by admitting that, yes, during its most recent quarter, McDonald's surprised just about everyone by recording a 4.9% jump in comparable sales from the year-ago period. But don't stop worrying about Greece's effect on Europe just yet.
Even more concerning than a crumbling Acropolis is the potential currency fallout if Greece does default on its sovereign debt. A Greece default could effectively undermine the euro as a viable currency, and any positive benefit McDonald's is currently deriving from currency translations into U.S. dollars will rapidly dissipate. Recent data show that 41% of McDonald's revenue is derived from Europe, so a major hiccup lower in the euro could easily lead to a string of earnings misses in the future.
The dreaded "I" word
Inflation has a push-pull effect on McDonald's, but I feel it would cause greater harm than good. Rising prices everywhere push more consumers to be conscientious of costs, which could in theory drive them to eat even more at McDonald's.
Likewise, though, based on comments from McDonalds' management, food inflation costs for the remainder of 2011 are expected to rise by 5%, up from a prior forecast of only 4.5%. Rising food costs could put a damper on McDonald's margins unless it passes them onto consumers, and consumers may in response just choose to eat at home. Although quiet of late, the dreaded "I" word is still lurking, and it could pose significant problems for McDonald's.
Monkey see, monkey do
A major reason McDonald's has been so successful in acquiring market share from its rivals has to do with its ability to adapt to changing consumer habits. By adopting healthier menu items and remodeling many of its U.S. locations, McDonald's has been able to widen its appeal to more consumers.
Unfortunately, being the first to innovate only means others are soon to follow. Within the past few years, Jack in the Box (Nasdaq: JACK) and Wendy's (NYSE: WEN) have renovated their overall appearance while introducing healthier menu items. What little benefit McDonald's had gained through renovating its image is nearly washed out as its competitors are constantly playing a game of monkey see, monkey do.
Overvalued meal
My final concern with McDonald's relates to the company's current valuation. Over the past decade McDonald's has vastly outperformed the Dow Jones Industrial Average (INDEX: ^DJI) (or really any index for that matter) regardless of macroeconomic conditions. Unfortunately, this outperformance has sucked nearly all of the remaining value out of the stock.
Source: Morningstar.
Since 2002, McDonald's price-to-book has more than tripled from 2.0 to 6.4, while its price-to-free-cash-flow has doubled from 7.1 to 14.3. Compare these figures to those of Darden Restaurants (NYSE: DRI), P.F. Chang's China Bistro (Nasdaq: PFCB) or Brinker International (NYSE: EAT), which all pay out similar dividend yields yet sport noticeably cheaper price-to-book and price-to-cash-flow valuations. At some point, value investors may wake up and realize that this stock is a value menu in name only.
Foolish roundup
Unlike previous stocks I've bashed, I'm not willing to take an extended long-term bearish approach on McDonald's despite concerns I have about its future growth prospects. What I am willing to go on record as predicting is that, in five years, McDonald's will be lower than it currently trades at. The dividend history is fantastic, and I love a quarterly disbursement just as much as anyone, but you simply can't squeeze blood from a turnip. There's no value left for shareholders at these levels, and investors would be wise to look elsewhere in the restaurant sector.
Now it's your turn to weigh in by voting in the poll below on whether you think McDonald's is headed for higher highs -- or perhaps its own version of the dollar menu. Also consider adding McDonald's to your free and personalized watchlist to keep up on the latest news with the company.
